copyright 2002-a.s. cebenoyan1 finance 208 seminar in financial institutions professor a. sinan...

Copyright 2002-A.S. Cebenoyan 1

Finance 208Seminar in Financial Institutions

Professor A. Sinan Cebenoyan

Frank G. Zarb School of Business

Hofstra University

Overview

Set one


US Depository Institutions

• Incentives, always incentives!

• Commercial Banks

• Thrifts

S&L’s and Savings Banks

Credit Unions


Commercial Banks

• 1985----->>> 14,416

• 1998----->>> around 9,000

• Why? Failures and M&A

• Community, Regional, Super Regional, and Money Center Banks


Commercial Banks continued

• Assets: Business Loans (C and I)

Securities

Mortgages

Consumer Loans

Other (LDC)



• Liabilities: Deposits

transactions

NOW

Savings and Time

Negotiable CD’s

Borrowings and Other



• Off-Balance Sheet Activities

Fee-related activities

Letters of Credit

Derivatives

Swaps


Regulation

• FDIC

• COC

• The Fed


Thrifts

• Savings and Loans

Long-term mortgages backed by short-term

savings deposits (helped by the yield curve)

Disintermediation

Regulation Q

DIDMCA

Regulatory Forbearance


Thrifts continued

• FSLIC in trouble.>>>>FIRREA (1989)

SAIF under FDIC

RTC

strengthen capital requirements

QTL test

Number of S&Ls down sharply


Thrifts continued

• Savings BanksNew England

mutual to stock

more diversified than S&Ls (assets)

more reliant on deposits >>less borrow

State regulators


Thrifts continued

• Credit Unions65% of assets in small Consumer loans

hold large amount of Government Sec.’s

Residential mortgages very small

lending funded by savings deposits

NCUA and NCUIF


Insurance Companies

• Life Insurance Companiesdeath, illnesses, and retirement

• Property-Casualty Insurancepersonal injury and liability

accidents, theft, fire...


Life Insurance Companies

• Life Insurance

Ordinary Life (Term, Whole, Endowment

Variable, Universal, VariableUniversal) ---- 58%

Group Life --- 40%

Industrial Life ---- 0.2%

Credit Life ------ 2%


• Other Life Insurer Activities

Annuities

Private Pension Funds

Accident and Health Insurance

• Balance Sheet

Assets>>15.9% Gov.Sec., 65% corp. Bonds and stock, 8% mortgs.,

balance policy and other loans

Liabilities>>53% net policy reserves

• Regulation >> McCarran-Ferguson Act ‘45


Property-Casualty Insurance

• PC Insurance

Fire Insurance

Homeowners

Commercial

Marine

Auto liability+ PD, Liability other


• Balance Sheet and Underwriting Risk

Loss Risk >>>Predictability:

Property(more) vs. liability(less predict.)

Severity vs. Frequency

Long tail(claims later) versus short tailLoss ratio (Losses/Premiums)


Securities Firms and Investment Banks

• Size, Structure, + Composition of Industry

Very Large number of firms

Sizes >>>Merrill Lynch to regionals

Activities: Investing, Investment Banking (IPO, PP) Market Making, Trading (Pure Arbitrage, Risk Arbitrage, Program Trading), Back-Office and Other


• Balance Sheet and Recent TrendsCommissions down after crashes, but up mostly in the 90’s. Underwriting and Holdings of Fixed income securities >>> Risk implications

Assets: Long Positions in Securities and Commodities (26%) and Reverse

repurchase agreements (35%).

Liabilities: Repurchase agreements (47%)

securities and comm. sold short +loans+equity

• Regulation: SEC, NYSE, NASD, SIPC


Finance Companies

• 2 Major Types:

1) Installment (auto) loans to consumers

2) Consumer+corporate loans, Factoring

• Commercial Paper used in Financing

• No Deposits -->>> Not much regulation


Mutual Funds

• Diversification

• Lower Transaction Costs

• First in Boston, 1924,

360 in 1970

about 8,000 today ($5 trillion managed once) after last 2 years maybe $2-3 trillion!


Mutual Funds continued

• Short-term fundsTaxable or tax-exempt

Money market mutual funds

• Long Term FundsBond, income, and equity funds

Returns: income and dividends,

capital gains when sold, capital

appreciationMarked-to-Market daily

NAV

open versus closed-end

• Load Funds, REITs

• Balance Sheets:• MMMF 75% in short

term securities (foreign and domestic deposits, RP’s, CP, US gov.secs)

• Long term Funds 63% in stocks, US Treasuries and muni. bonds 23%.

• Regulated by the SEC, and States.


Overview of the Federal Reserve System

• Today, Fed’s duties are:• Conducting the nation’s monetary policy…in

pursuit of full employment and stable prices

• Supervising and regulating Financial Inst.s…safety and soundness…credit rights of consumers

• Maintaining the stability of the fin’l system ...containing systemic risk

• Providing certain fin’l services…major role in operating the nation’s payment system


Background• History of failures.

• December 23, 1913 Wilson signs into law the Federal Reserve Act

• To provide for the establishment of Federal Reserve Banks, to furnish an elastic currency,…,effective supervision…

• Other Acts followed to fill in other needs

Structure of the System•Board of Governors, Washington, D.C.

•12 Regional Federal Reserve Banks

•Federal Open Market Committee (FOMC)

•Board + President of NY Fed+ 4 rotating other presidents


Three Major Tools Fed uses to conduct Monetary policy:

•Open Market Operations - FOMC

•Reserve Requirements - Board has sole authority

•The Discount Rate - Board approves any change by a Fed bank

Banking Supervision

•shared with OCC + FDIC

•All member banks + BHCs + Foreign activities of member banks, US activities of foreign banks, Edge Act corporations


Federal Reserve Banks•12 regional feds with 25 branches: Operate the nationwide payments system, distribute the nation’s currency and coin, supervise, regulate member banks and BHCs, and serve as Banker to the US Treasury.


Monetary Policy

• Goals of Monetary Policy– maximum employment

– stable prices

– moderate long-term interest rates

• Reserves Market– Demand for Reserves

» Required reserves and excess reserves

– Supply of Reserves

» (Borrowed Reserves) Discount Window and (Nonborrowed Reserves) Open Market Operations

– Federal Funds Rate


Open Market Operations• Buying and selling of Securities by the Fed

– Purchase adds to nonborrowed reserves, a sale reduces them

– When fed buys securities, it pays by issuing a check on itself, when the seller deposits the check in her bank, the bank presents the check to the Fed for payment, and the Fed increases the reserve account of the seller’s bank at the federal reserve bank. The reserves of the seller’s bank rise with no offsetting decline elsewhere; consequently, the total volume of reserves increases.

– This dollar for dollar change in the reserves makes Open M. Ops. The most powerful, flexible, and precise tool of monetary policy.


• Other factors Influencing Nonborrowed Reserves (Technical factors):– Amount of currency in circulation

– Size of Treasury Balances at the Fed

– Volume of Federal reserve Float

• Techniques of Open Market Operations– Outright Purchases and Sales

• through auctions with dealers

– Repurchase agreements

• for temporary adjustments, buy from dealers who will repurchase by a fixed date at a fixed price.

– Matched Sale-Purchase transactions


• The Discount Window• Complements Op. Mkt. Ops…and implementation

of longer-term monetary policy goals

• Facilitates B/S adjustments of individual banks that face temporary changes in asset-liability structure

• Uniform Discount rate across all Reserve Banks

• If holding deposits subject to reserve requirements then eligible for discount window access.

• Borrowing either done as discounting paper, or as an advance secured by collateral

• Adjustment Credit: for short-term liquidity needs– Fed provides credit at its own discretion

– Borrowing must be for appropriate reason

– other sources must be sought first


• Seasonal Credit helps small institutions lacking access to national money markets, e.g. agricultural banks

• Extended Credit: provided when exceptional circumstances or practices adversely affect an institution.

• Emergency Credit: “unusual and exigent” circumstances, not used since the 1930s

• Reserve Requirements:– Since the MCA of 1980 all depository institutions, regardless of

membership in the Fed, are subject to reserve requirements

– 8-14 percent on transaction deposits, 0-9 percent on nonpersonal time deposits

– The MCA broadened the reserve base and improved the predictability of the link between reserves and M1

– In 1982 switch to Contemporaneous reserve requirement scheme tightened the real-time link between M1 and reserves.

– 1984 focus shifts to M2, as M1 becomes highly sensitive to interest rates


• Consumer Protection– Federal reserve writes regulations to implement Consumer

protection laws enacted by Congress

– Federal reserve enforces state-chartered member banks

– staff examiners regularly evaluate banks

• The Fed and the Payments System – The Fed is an active intermediary in clearing and settling interbank

payments, as they maintain reserve or clearing accounts for the majority of depository institutions.

– Cash Services:Currency and Coin…ensure enough in circulation to meet public’s demand. Notes issued by the Feds, coin by the Treasury.

– Noncash-Transaction Services• Check processing

• Electronic Funds transfer: Fedwire for large ACH for small-dollar payments


• Fiscal Agency Functions– Maintaining the Treasury’s funds account

– Clearing Treasury checks drawn on that account

– Conducting nationwide auctions of Treasury securities

– Issuing, servicing, and redeeming Treasury securities

• International Services


Why are Financial Intermediaries Special?

• Flow of Funds in a world without FI’s

Householdsnet savers

Corporationsnet borrowers

Cash

Equity and debt claims

•Monitoring costs (covenants)

•Liquidity

•Price Risk


• Flow of funds in a world with FI’s

HouseholdsFI

(brokers)

-----------FI

(asset-transformers)

Corporations

Cash

Deposits and insurance policies

Cash

Equity + Debt

… …

•Brokerage Function reduce transaction costs, imperfections etc..

•Asset transformer: purchase Primary Securities and sell deposits, insurance policies,etc.(Secondary securities)


• Information Costs

FI does the monitoring to reduce agency costs

hence a delegated monitor

economies of scale

frequent monitoring in Bank Loans allows the FI to gather information constantly (insider?)

Reduction of imperfections and information asymmetries

• Liquidity and price risk

Through diversification, FI’s offer highly liquid and

low price -risk contracts on the liability side of their

B/S while investing in relatively illiquid and higher

price-risk securities of corporations on the asset side.


• Reduced Transaction Costs

Bulk asset purchases reduce costs (mutual funds and pension funds)

Bid-ask spreads are lower in large quantity purchases

• Maturity Intermediation

Other Aspects• Transmission of Monetary Policy• Credit Allocation (residential mortgages, farming loans…)

• Intergenerational Wealth Transfers (Time Intermediation)

• Payment Services

check clearing and wire transfers


Specialness and Regulation

Negative externalities - Runs - RedliningNet regulatory burden (Difference between the private benefits to

an FI from being regulated (guaranties) and the private costs of regulations (examinations)).

• Safety and Soundness RegulationDiversification (no more than 15% of own equity capital can be lent to any one company or borrower

Capital requirements

Guaranty funds

Examinations


• Monetary Policy Regulation

Reserve Requirements

• Credit Allocation Regulation

QTL

• Consumer Protection Regulation

CRA

• Investor Protection Regulation

Securities Act of ‘33, Investment Co. Act ‘40

• Entry Regulation

copyright 2002-a.s. cebenoyan1 finance 208 seminar in financial institutions professor a. sinan...

Documents

ldc slide

ncuif slide

money center banks slide

credit life

commercial banks thrifts

cebenoyan6 commercial

cebenoyan5 commercial

cebenoyan4 commercial